RingCentral Inc (RNG) 2016 Q3 法說會逐字稿

Greetings and welcome to the RingCentral third-quarter 2016 earnings conference call.

(Operator instructions)

As a reminder this conference is being recorded.

I would now like to turn the conference over to your host, Darren Yip, Director of Investor Relations for RingCentral. Thank you Mr. Yip, you may begin.

Thank you.

Good afternoon and welcome to RingCentral's third-quarter 21016 earnings conference call. I am Darren Yip, RingCentral's Director of Investor Relations. Joining me today are Vlad Shmunis, founder, chairman and CEO; and Clyde Hossain, Chief Financial Officer. Our format today will include prepared remarks by Vlad and Clyde followed by Q&A.

The purpose of our call today is to provide you with information on our third-quarter performance as well as to provide our financial outlook for the fourth quarter and full-year 2016. Some of our discussions and responses to your questions may contain forward-looking statements. These will include statements on our expected financial results for the fourth quarter and full- year 2016 and our expected annual revenues several years out. In addition, these will include our future plans, prospects and opportunities, trends in the business communications market and our expectations regarding our expansion up market and our success in the enterprise segment.

We'll also be making forward-looking statements about our competitive position ; our relationships with our carriers, channel and strategic partners; the expected benefits of our investments into technology; our open platform and integrations; our products, including Glip and Contact Center, and our global office solution; our growth strategy, current and future market position and expected growth.

These statements are subject to risks and uncertainties. Actual results may differ materially from our forward-looking statements and projections for a variety of reasons, including, but not limited to, general economic and market conditions; the effects of competition and technological change; success of marketing, sales and retention efforts; and customer demand for and acceptance of our products and services.

A discussion of the risks and uncertainties related to our business is contained in our filings with the Securities and Exchange Commission and is incorporated by reference into today's discussion. We disclaim any obligation to update information contained in our forward-looking statements whether as a result of new information, future events or otherwise.

I encourage you to visit our Investor Relations website at www.IR.RingCentral.com to access our earnings release and slide presentation, our non-GAAP to GAAP reconciliations, our periodic SEC reports, a webcast replay of today's call and to learn more about RingCentral. For certain forward-looking guidance a reconciliation of the non-GAAP financial guidance to the corresponding GAAP measure is not available as discussed in detail on our Investor Relations website.

With that, let me turn the call over to Vlad.

Thank you, Darren.

I'm pleased to report that Q3 was yet another solid quarter with strong top line growth and continued margin expansion. We grew overall revenues for the quarter to $97 million. Driven by a software subscription revenue growth of 31% year-over-year. These solid results gives us more wind in our sails as we continue our journey to $1 billion in annual revenues over the next four to five years.

We're focused on balancing three things concurrently: continued industry-leading growth, expanding margins, and investing in enterprise. Q3 results demonstrate that the strategy is working. One, we drove revenue growth at the high end of our guidance. Two, we expanded margins above our outlook, and three, we are now seeing meaningful traction in the enterprise segment.

As we have discussed before, participation in the small, mid and enterprise customer segments simultaneously allows us to go after an entire untapped market of more than $50 billion globally. As a result, we continued to deliver industry-leading growth and scale that outpaces our competitors.

Total residential office ARR grew 39% year-over-year. Our up market segment for customers with over 50 seats, doubled year-over-year and comprised over 40% of our total office bookings. And since it was as last quarter, I would announce that our next of over $1000 MRR in channel represented over 70% of office bookings.

We are also pleased to report that about 75% of net new office bookings are now under contract. This shows a longer commitment from our customers, particularly as we expand our market. Office net retention remained over 100%.

As I mentioned earlier, we are having meaningful success in our enterprise segment, which we defined as over 1000 seats. We continued to see an increasing number of over $1 million contract value deals this year. In fact, our enterprise sales pipeline has nearly tripled since the beginning of the year.

For instance, we closed a 1700 office user deal along with a 800 contract center seats at a private healthcare institution. This was a take away from a direct cloud competitor. We won the deal because of our superior quality of service and our open API platform.

Another example this quarter is our largest new customer win. A 5000 user deal as a multi billion-dollar restaurant chain with a total contract value over $3 million. This is a replacement of a legacy Avaya system across multiple locations.

This momentum has not gone unnoticed. We are pleased to be the recipient of two prestigious industry commission awards for our leadership in product innovation and execution. First, RingCentral has been named a leader in the Gartner Magic Quadrant for the UCAAS segment worldwide for the second year in a row.

In fact, we further extended our leading position versus our competitors from last year. This was due to our strong product innovation, ease of use and administration and overall customer satisfaction. In addition, Frost and Sullivan just named RingCentral the 2016 UCAAS company of the year for North America.

Again, our efforts in overall vision and product innovation were highlighted as key drivers. These awards demonstrate our deep commitment to product innovation. We believe our higher R&D investment versus our direct competitors are paying off. Our commitment to innovation has been the driving force behind RingCentral success and we now have over 100 issued patents.

I want to take this opportunity to thank all of our employees for their commitment to innovation and excellence. We believe RingCentral is increasing its lead as the largest and fastest growing pure-play cloud UCAAS provider worldwide.

In the first three quarters of the year, we already had four major releases offering central office, focusing on enhancing our enterprise capabilities and expanding our global reach. In addition we have re-released RingCentral [VOIP] as a native application for iOS and android. This resulted in significantly enhanced performance and higher adoption.

We also had eight major updates to our developer platform that further expanded our out-of-the-box integration with other cloud solutions. During the quarter we also had a chance to showcase some of this innovation at our first user conference in San Francisco. Customer feedback reiterated our belief that modern enterprise communications is about much more than on premise PBX replacement.

Customers want a completely integrated, open, multimodal business communication system. They want a solution that empowers their workforce to work anywhere, anytime and on any device. We have built the only open cloud communications platform to meet their needs.

We seamlessly integrate voice, video conferencing, messaging, team collaboration, custom workflow enablement and contact center. We were particularly pleased by the customer excitement around our team messaging and collaboration solution.

The boundaries between communication and collaboration are blurring. We anticipated this trend more than a year ago when we squired Glip. Our team messaging and collaboration has influenced more than a couple dozen up market wins this past quarter alone. One of those wins was a leading specialty construction company with over 1000 users across multiple locations. This was also a competitive take away from yet another cloud competitor.

Our open platform was also well received by conference SNDs. We joined forces with strategic partners such as Google, SalesForce, Dropbox and Opta to demonstrate the power of our open ecosystem.

Customers want to integrate their communications platform with other cloud solutions and with their custom applications. The integrations provide enhanced productivity for their employees and better experience for the customers. For instance, the 5000 user, multi billion-dollar restaurant chain mentioned earlier will leverage our open API to inform their customers of the status of their to-go orders.

We further strengthened our platform offering in Q3. Our ISV partners added eight new out-of-the-box integrations, bringing the total to over 45, with over 80 new custom integrations, bringing the total number of custom driven integrations to over 300. Open API integrations are critical for our enterprise customers and differentiate us from our competition.

We also continue seeing great progress with international enterprises, based on our rapidly expanding global office capabilities. We added 11 countries to our offerings and increased the number of customers by 50% quarter-over-quarter to nearly 400.

For example, we won of a 500 user account at Sugar CRM. Sugar CRM was looking for provider with a complete cloud communication and collaboration solution with global capabilities. We replaced silos of multiple standalone communication applications including voice, video, web meeting, and conferencing. And we were able to unify their eight offices around the globe, something the previous providers could not do.

Our contact-centered business experienced a record quarter with an over 50% quarter-over-quarter increase in bookings. We had multiple wins with over 100 contact center seats. For example, this quarter we won we a 100 contact-centered seat deployment as one of Florida's major news publications. This was along with 400 RingCentral offices replacing a legacy on-prem system.

For another example, we expanded our presence at Wyndham Capital Mortgage. There we added 125 contact-centered seats to the pre-existing 350 RingCentral offices.

On the go-to-market front, our indirect channel performed really well, representing 25% of our total ARR. Our master agent, Envar, had a record quarter of bookings. They continue to bring us larger and larger deals, including the 5000 seat deal I mentioned earlier. To continue the momentum, we included and activated nearly 400 new sub-agents and signed Intelisys, one of the key master agents in the US.

Our partnership with Google, announced in late Q2, is also bearing fruit. In Q3 we want a Google referral deal for an initial 300 users at G4S in the UK, one of the largest multinational security services companies in the world. Our integration with GSuite, formerly known as Google S, was key to the win. We also expanded our Google partner network to include three strategic UK-based resellers. CTF, Netinnovate and Whitetrans.

On the carrier side, we saw some nice upmarket wins, as well. In particular, we had several important wins with our North American carrier partners. This included a 250 user deal at the leading national fast food chain and 325 user win at a well-known apparel retailer.

In conclusion, we're very happy with the quarter. We feel that momentum is on our side with our largest win ever. Broad industry analyst recognition and strong customer demands for our open and complete cloud communication and collaboration solution across the board. We believe we are well on our way to our $1 billion annual revenue target in four to five years and I look forward to a strong finish to the year.

Before I turn this over to Clyde for more color on the financial results, I would like to remind everyone that we will be hosting our first investor day on November 15 in San Francisco. Please join us as we will be sharing insight and updates on our business strategy, product innovation, partnerships and vision for the future.

And with that, I will turn the call over to Clyde.

Thank you Vlad and good afternoon everyone.

Before I began, I want to ask that you refer to the slide deck on our investor relations website, which will help summarize the key points in our call today as well as provide some supplemental information. Q3 was yet another strong quarter for RingCentral. We delivered revenue growth at a high-end of our guidance range, along with improvements in operating margin and earnings per share. Q3 was underscored by 31% software subscription revenue growth year-over-year and non-GAAP software subscription gross margin of over 80% amongst the best in class of SaaS companies.

Non-GAAP operating margin of 2.3% in the quarter represents a 40-basis point sequential increase over Q2. We also continued to see positive free cash flow generation in Q3 for the third consecutive quarter. Overall, we saw solid results across the board as we continued to balance revenue growth, improving profitability and making investments in our expansive up market to increase penetration of enterprise size customers.

Total annualized exit monthly recurring subscriptions, or ARR, grew to approximately $390 million, up 31% year-over-year and 7% sequentially. The ARR for RingCentral office grew to approximately $317 million, up 39% year-over-year and 9% sequentially. Upsells continue to outpace churn in Q3, as RingCentral office net monthly subscription dollar retention was once again over 100% and overall net monthly subscription dollar retention also remained over 99%.

In Q3, over 40% of our new office business came from existing customers, which we believe demonstrates satisfaction with the RingCentral platform, along with tailwinds from land and expand with larger customers as we consistently move up market. Software subscription revenue in Q3 was 91.9 million, up 31% year-over-year and 7% sequentially.

The indirect channel contributed about 25% of revenues in Q3 with bookings relatively consistent with Q2. As you may recall, Q2 was the strongest quarter ever for our channel new business. Other revenues were $5 million, bringing total revenue for the third-quarter to $96.8 million.

As a reminder, in Q1, RingCentral transitioned direct form sales to an agency model in which we received the commission for most of our phone sales, instead of separately recognizing the full sale price and cost of the product. On a comparative basis, (technical difficulties) adjusted in the prior period on an apples to apples basis as if the agency business model had been implemented last year, total revenues grew 30% year-over-year and 5% sequentially. A full reconciliation is available on our earnings slide deck on our IR website.

Before I move further down the income statement I want to remind you that my commentary will be focused on non-GAAP results and guidance. Unless otherwise indicated, all measures that follow are non-GAAP. A reconciliation of all GAAP to non-GAAP results is provided with our earnings press release issued earlier today and in the slide deck on our IR website.

Our software subscription gross margin remained at 80% during Q3 and represents about a four point improvement year-over-year, once again demonstrating the leverage from our multi-tenet SaaS model. Gross margin from other was 16% in the quarter. The other revenue line includes commissions under the agency model, professional services and revenues from rental and carrier sales [of phone]. Gross margins were down quarter-over-quarter from 28% in Q2, primarily due to the timing of revenue recognition of Pro services in some of our larger deals and a mix of revenues within the other revenue categories.

On a sustained basis we expect other revenue gross margins to be 20% plus or minus a few points. Total gross margin was 77%, up about three points year-over-year and in line with Q2. Sales and marketing expenses were about $47 million for the quarter, or 49% of revenues. This was up from 44% in the third quarter a year ago and from 47% last quarter as we continue to invest in long-term growth. These expenses include investments we're making in the enterprise segment, which remains a significant opportunity for us with meaningfully higher lifetime values.

Our unit economics continue to be attractive. For each dollar invested in sales and marketing we continue to see $8 of revenue and about $6 of gross profits over the projected life of an office customer. R&D expenses were $14 million in the third quarter, 14% of revenues, down from 15% in Q3 a year ago and from 16% last quarter.

As Vlad indicated, we continue to invest more than our competition, which is manifested in our industry-leading product, validated by multiple third parties including Gartner, and Frost and Sullivan. This, in turn, is reflected in high customer retention and consistent high growth rate per office ARR at around 40% and organic revenue growth rate about 30%. G&A expenses were about $11 million in Q3, or 12% of revenues, down from 13% in the year ago period and in line with Q2.

Netting it all out, our operating profit was 2.2 million for an operating margin of 2.3%, about the high end of our guidance range of 1% to 2%. This is an improvement of approximately 160 basis points from the third quarter a year ago and up 40 basis points from last quarter.

Net income improved to $2 million compared to $300,000 in Q3 of last year and a $1.5 million profit last quarter. Earnings per share was $0.03, above our Q3 guidance range of breakeven to $0.02. Share count was 77 million fully diluted shares.

On a GAAP basis, our Q3 net loss was $8 million, or a loss of $0.11 per share. The difference between our GAAP and non-GAAP results was $10 million, or $0.14 per share. Of this, $0.11 was driven by stock based compensation, while $0.03 was due to the combination of currency remeasurement of our intercompany balances in the UK, as well as amortization of intangibles and other items related to the Glip acquisition.

We ended Q3 with cash and short-term investments of $152 million, compared to $148 million at the end of Q2. Deferred revenue was $43 million as of September 30, an increase of $42 million in Q2 and $34 million a year ago. For the quarter, cash flow from operations was $8 million, compared to $10 million for Q2 and $2 million in the same period a year ago. Recall that Q2 benefit is from improved working capital from the transition to the agency model and catch-up payments from our carrier partner. Free cash flow was $4 million in Q3, marking it our third consecutive quarter of positive free cash flow generation.

Now for our outlook for the fourth quarter and full year 2016. For the fourth quarter, we expect software subscription revenue of $98 million, plus or minus $0.5 million, which represents annual growth of 28%, plus or minus a point. We expect total revenue of $102 million to $104 million, which represents growth of 26% to 29% on a comparative basis with 2015 results adjusted to the agency model.

We expect non-GAAP operating margin of 1.5% to 2.5%. We expect non-GAAP earnings per share of $0.02 plus or minus a penny based on $79 million weighted average fully diluted shares. The difference between our Q4 GAAP and non-GAAP EPS is expected to be approximately $0.12 including $0.11 of stock-based compensation and one penny of acquisition-related intangibles. This excludes any effects from currency remeasurement, which is difficult to forecast.

For the full year 2016 we expect software subscription revenue of $356 million, plus or minus $0.5 million, which represents annual growth of 31%. We are raising our total revenue guidance to $376 million- $378 million, up about $4 million from our previous guidance of $370 million to $375 million.

Adjusting 2015 results to the agency model, this implies year-over-year growth of 31% to 32%. We are also raising our outlook for non-GAAP operating margin by approximately 20 basis points to a range of 1.8% to 2.1% up from 1.5% to 2% we provided last quarter. We expect non-GAAP earnings per share of $0.07 to $0.09, up from $0.04 to $0.08 previously. We expect weighted average fully diluted shares to be $77 million.

We expect free cash flow for the year of approximately $11 million to $14 million, up from $9 million to $12 million previously. In summary, Q3 was another great quarter that puts us well on track to achieve our $1 billion annual revenue target in the next four to five years.

As Vlad mentioned earlier, I want to invite you all to learn more about our business and our future strategies at our investor day on November 16 in San Francisco. For more information please reach out to Darren or check our investor relations website, as registration is required to attend.

With that, I will turn the call over to the operator for Q&A.

Thank you.

(Operator instructions)

In the interest of time if you could please limit yourself to one question and one follow-up question so that everyone may have a chance to ask a question. Our first question comes from the line of Terry Tillman, Raymond James & Associates, Inc. Please proceed with your question.

Good afternoon, gentlemen. First, congratulations. My question is going to be around the enterprise business and the follow-up is going to be on the Google relationship. First on the enterprise business, could you talk about what kind of selling motion is involved in these bigger deals, like a 5000 seat deal and compared to your upmarket and your SMB business, is it a dramatically different type of sales process and how well is your sales team architected to handle those kind of opportunities -- is my initial question.

Yes, hi Terry. Vlad here. Thank you very much for the congratulations. We did have a good quarter.

So let me take it in the order you gave. So as far as our enterprise situation is concerned, so we are seeing continued strong traction and expansion into the enterprise. And as we have just reported and were very grateful for that is we have 5000 seat win, quite big for us, over $3 million in TCD. So this is a really good sign.

And we been on record I think for quite some time now saying that it is only a matter of time until we start getting multi-thousand seat wins and we're now definitely seeing that. So we do believe that there is more to come as the entire market including even sizable enterprises tilt more towards the cloud.

Now as far as the dynamics between enterprise and SMB are concerned, that is actually a great question. There are trade-offs. And trade-offs are along the lines that we get faster return on our investments with smaller businesses. But we get meaningfully greater lifetime value and in the end, it results in improved growth over time, so we get that from the enterprise.

So the balancing act that we are in at this point and have been for some time is really how to best balance our overall growth against operating margin expansion and how to balance that with our strategic initiatives of expanding into the enterprise channel. And frankly we feel very, very good about the choices we have been making so far. We have mentioned last quarter -- actually two quarters ago, for two quarters in a row we've been saying that our mid market segment is now our most profitable segment on the ROI basis and we expect to see similar improvements as we march up market including multi-thousand person enterprises.

Okay. And if I can get in this follow-up question, it actually relates to Google. We talked to Google resellers and it does seem like there is growing interest from the reseller standpoint. But what's the motivation of Google working with you guys and maybe their interest in that UC market and how formal of a relationship is that? Thank you.

Great question. We feel very lucky and grateful for the fact that we were one of the -- in the first batch of solutions that Google chose to work with in their recommended for Google At Work program. Look, it is still early, but there is very positive traction. So we are working with Google directly.

We have had a customer conference, our first user conference about one month ago. Google participated and their representative sat on the panel, which was quite helpful, actually. We originally participated in Google's events at the regional level in their partner events. And we are working directly with them in identifying joint account opportunities that we're jointly pursuing.

Again, it is early, but we are seeing very nice wins from this relationship. So some of the examples we have mentioned is Cardinal Financial, the G4 S win. These were specific accounts brought to us by Google or Google resellers.

As far as how strategic it is to Google, that's probably more of a question to Google, frankly. But what we see is that we very, very nicely complement the G Suite products they have, used to be Google Apps, in that we allow a business to go full cloud across all of their business productivity needs, including business communications. And that is a big, powerful, valuable position and frankly as we sit here today, the only way that a business can truly go full cloud 100%, no on-prem across all productivity functions is really if you consider the Google G Suite and RingCentral combination together. So we like where we are with them.

Thanks a lot.

Thank you.

Our next question comes from the line of Bhavan Suri, William Blair & Company. Please proceed with your question.

Hello guys, congratulations and thank you for taking my question. Two, let's start off with the first one, just on AT&T and that relationship. Vlad, it would be great to get an update on how that's progressed. You gave the indirect channel, but it would be great to see what AT&T contributed and an update on that relationship would be helpful and then I have a quick follow up to Terry's.

Okay, fantastic. Hello, Bhavan. As far as AT&T is concerned, we continue seeing new business from all of our carrier partners. And that includes AT&T. We continue seeing record revenue, so revenue growth, both quarter-over-quarter and year-over-year from full carrier partners and that includes AT&T.

By way of example, our North American carriers continue bringing in meaningful deals and for example just this past quarter we had a 250 user win at a large fast food chain. We had another win, over 300 seats at a well-known apparel retailer, and these were brought by North American carriers.

So Vlad, if I may build on that question, carriers are part of our indirect channel. Indirect itself was about 25% of revenues in Q3, consistent with Q2 and up from about 20% a year ago. With indirect, we have seen VARs that are outpacing the carriers. That is driven by our continued investment in the VAR channels including new partners and that attracts them from existing partners.

As you would expect, VARs have responded to customer demand for cloud-based solutions so it's end user driven, it's more [pull]. Just to reiterate, one example we saw that Vlad mentioned in his prepared remarks is a 5000 person -- 5000 user win that came in from the channel. So that channel continues to do really well for us and we expect that to continue to do well.

Great. Just a quick follow up. Enterprise is obviously doing really well, I'd much rather get color on the enterprise pipeline. But typically the [reach] you guys have or a little larger and this seemed a little less, is there a shift towards enterprise and the longer sales cycle that might be responsible? Is the velocity run-rate business of the SNB market shifting?

Have you guys changed any of that strategy at all or is it still the same and it's just sort of an anomaly? How should we think about vis-a-vis the focus on enterprise wins but obviously since being a public company, you've typically [beaten] by more and I'm just trying to think about how we and investors should think through that.

Sure. A very fair question. From what we can tell we are still the fastest growing pure-play in the segment. And we are able to do that while not only remaining profitable but also growing our operating margins quarter-over-quarter.

But again, just to reiterate, it is a balancing act. So to make it very simple, we could grow a little faster if we were to not invest ahead of the curve, specifically into the enterprise channel.

So it is a conscientious trade-off that we're making in investing for the long-term while still keeping very respectable growth in business overall and in RingCentral office, which is a $300 million business recurrent revenue growing at about 40%. So this is not from our vantage point, this is not terrible numbers. But being able to do all of that and get these accounts, like for example the 5000 user win, we've mentioned already, it is a $3 million, over $3 million QCD that will play itself out over a few years. So that cannot but help our growth down the line.

So I just want to add that it is a song we've played before. We had very similar dynamics a while ago between small business and midsize market. And that one is now performing extremely well and mid-is now better ROIs than small. Again we're very confident that as we grow the sales force and train them and get our name better recognized in the enterprise segment, we should see improved performance and improved ROIs there as well, which in turn should help our growth.

Got it. Thanks, guys. Appreciated.

Your next question comes from the line of John DiFucci, Jefferies & Co. Please proceed with your question.

Thanks. My question has to do with cloud connect. I assume this is based on demand from large enterprises. Is this something that a lot of enterprises have been asking for and waiting for? Or is this something that should we perhaps, because of this, expect to see perhaps more of those large deals in the near-term?

Another good question here. The enterprises are definitely looking to shift towards the cloud. There is no doubt about that. We see that from enterprises directly. We also see this from our channel partners that are becoming more and more successful in their enterprise channel.

Now it is just a matter of technology that the larger the company and in particular, the larger an individual site is vis-a-vis the number of seats, the more likely it will be that they will want some type of a direct connect solution. So whether it be NPLS or some other ways of achieving the same result, the fact is if you want to provide quality service for a multi-thousand seat installation, then in some cases, having a direct connection, it does make sense.

Frankly, we have been hearing for some time that there were some confusion in the space as far as that [rink] will only go over the top. That's not true. But what we were able to do recently is make it very clear to the market, to the end customer as well as the our channel partners that as a matter of fact, not only do we support direct connect installations, but we're even able to prototype it and call it out explicitly. A lot of this was a matter of perception, but at this point in time I think those fears have been put to rest.

Got it. Thanks, Vlad. I might, the follow-up on another partnership, which have been talked about so far tonight, but a different one. Barracuda Networks, you just announced. Just trying to get an idea of what that opportunity is.

I think Barracuda, the CFO said [they end of life their] phone business which was $1 million to $2 million in revenue this past quarter. Is that the opportunity here and I'm sorry I don't know as I -- I'll do some more work on Barracuda but -- what is the opportunity with Barracuda with this new partnership?

We will have to see. Barracuda as a company that we're working with. And you're right, they did announce that they would like to get out of the communications business, of the voice part of the communication business to be clear. Though they have on-prem product that they chose to partner with us to migrate those customers to the cloud.

To be very, very clear, we have no interest and are in no way involved in anything on-prem. So we're not taking that business on at any stage. But we do have a migration agreement [let's say] this was negotiated with them, which basically allows us to market to those customers and to move them to our cloud.

And really, a big part of this is honestly not just even the install base there, but our ability to work with our channel to leverage their channel relationships. And as Clyde mentioned, channel is becoming more and more important for us. (inaudible) if that's the question. But certainly it's yet another way for us to acquire customers on a cost-effective basis.

Great. Thanks, Vlad.

Thanks.

Our next question comes from the line of Nikolay Beliov, BofA Merrill Lynch. Please proceed with your question.

Hi and thanks for taking my questions and congratulations on the results. Clyde I wanted to pick your brain on the margin trajectory going forward with these high level puts and takes. When I look at your business gross margins are at long-term levels, the ones you [got in during the IPO]. You're getting leverage from G&A and R&D, and sales and marketing has been going up by 100 basis points a year, [as percentage] of revenues over the last three years.

I just wanted to check on the commitment to margin expansion in the near-term and light of the investment in enterprise because mathematically at some point, G&A and R&D leverage is going to slow down and you have to start showing sales and marketing leverage. I'm just wondering how you think about that, involving the near and medium term.

Thank you, Nikolay, I'm happy to drill into that for you. If you look at, just to recap, our gross margin went through very significant expansion over the last couple of years, we are running at about 80%, which is at the high end of our target range and we continue to sustain that. So all new business that came in in the last quarter for example, the last couple of quarters, came in at about 80% gross margin which is meaningfully has seen 14 points improvement over a couple of years ago. We continue to see leverage in G&A and R&D and it will continue to do that. So that is point number one.

Point number two is, our unit economics, which I reiterated in our earlier remarks, continues to be great. Every dollar we invest in sales and marketing gets $8 of lifetime revenue and $6 of lifetime gross profits. So very, very meaningful.

Point number two, the market opportunity is still very large and very underpenetrated. We've got a terrific product which uses those unit economics. So we already did well in the small business and medium-size business as we invested a couple of years ago and those continue to do well.

The last frontier in this whole thing as enterprise. As Vlad mentioned earlier, characteristic enterprise you invest now payback in aggregate is later down the line, so that obviously that will put some headwinds on margin but we are seeing early successes. We announced a couple thousand plus enterprise class customers on this call today, and I think we also said our pipeline is about 3X what it was earlier this year. So we are very optimistic about that, that being the last frontier.

Having said all of that, you saw every quarter I believe this year, including the most recent quarter, where we did 30, 40 bps of operating margin improvement. So in summary, we're committed to operating margin expansion. I think there are some dynamics in the market we're trying to manage while still delivering improvement in margin. I think as you go out to the medium-term, I think you will continue to see us do that as enterprise [starts] yielding better returns will allow us to do that. And we're still committed to our long-term target margins of 20% to 25%.

Got it. As a follow-up, Clyde before revenue came in flattish quarter-over-quarter and last year was up sequentially, just wondering if there were -- what the puts and takes were in the quarter in NDR?

No. I don't think there's anything to read into that, Nikolai. It was up meaningfully year-over-year I think 20% and 30%. I wouldn't read too much into the trends quarter-over-quarter.

I think as time goes on you will see improvement in deferred revenue where I think we have said about 75% of our new business customers over two thirds, 75% sign contracts, some of them prepay, which of course creates deferred revenue. So I think the flattish nature quarter-over-quarter I would not read much into that. I think year-over-year is likely more indicative.

Got it. Thank you.

Thank you.

Our next question comes from the line of George Sutton, Craig-Hallum. Please proceed with your question.

Thank you. Vlad, earlier in the call you mentioned the enterprise sales pipeline had tripled. I know a question was asked about this, but I don't think we went into some of the components of what is driving that. And I wondered if you could also discuss any changes you are seeing in close rates relative to that kind of growth.

Sure. So this goes back to our continued investment in the enterprise channel, which it really comes from two sites. Two vectors to this growth. So one is our direct sales force.

It's fairly simple, we are rapidly building out our enterprise sales force. We are doing it in a judicious manner. So we're hiring people and onboarding them at a pace that still allows us to stay profitable and to still continue growth overall. So we're not interested in revenue at any cost, we're interested in good solid revenue with good ROI.

But having said that, we are just fortunate to be in a position to where we are able to be onboarding people across board and specifically in the enterprise direct segment. So this is the first vector.

The second vector is indirect as led by the VARs channel and there we're just seeing more and more VARs we are adding to the family as well as our existing VARs becoming more productive as they get better familiar with the platform and also frankly as demand, interest from enterprises increases. So these are both sustainable trends.

Actually as a matter of fact, we're quite optimistic that we will see both accelerated growth as well as improving ROI as this strategy evolves. Again, we have seen exactly the same thing in the mid market. In enterprise it will take a little bit longer, but the stakes are worth it. Those customers are extremely valuable. And again, case in point, our 5000 user deal did come from the channel. So we're quite hopeful that there will be more of those in the foreseeable future.

Let me ask you a quick follow-up relative to the context [on your side]. So obviously, tons of M&A in that space, (technical difficulties) how that M&A and the impact of that might've impacted some of your opportunities I would think in a positive way and your ability to deliver more directly. Thanks.

Sure. So we had of very good quarter for our contact center business. So by no means do we see any type of a slow down nor do we hear concerns about any of the competitive -- from the competitive perspective where some of the players now haven't gone through the M&A process. There is very strong demand.

We have very confident and happy with our strategy of combining the best in class UCAAS solution. Ours were the best in class contact center -- cloud-based contact center solution, and that's played out well. So we continue seeing strong execution and we don't see any reason why it would be slowing down in the immediate future or in the foreseeable future, I should say.

Our next question comes from the line of Meta Marshall, Morgan Stanley. Please proceed with your question.

Great. Thanks guys and congratulations on the quarter. A couple of questions just about the VAR business, just as professional services ticks down a little bit this quarter, it brought to mind a question of would you expect the VARs to do more of the professional services and future deals? Is that live growth or would you guys still have the same professional services contribution?

And then the second question with indirect channel being flat, I know we kind of talked about it, but is that mostly VARs doing larger deals with longer sales cycles perhaps, or is it just the element that you already addressed of the carriers growing a little bit slower than the VAR channel.

Thank you, Meta, let's clarify a couple of things. Indirect was flat as a percent of revenue but it grew. So I don't want people to interpret that indirect was flat. And so we're very excited of that, there are two components of that, there's the carriers which Vlad pointed out earlier also grew as well. But the bigger growth comes from VARs, which were very excited about, just to clarify that.

On the [prof] service business, that business grew I think what you described as the gross margin, it had some near-term effects in Q2 where the way it works is we incur costs and then the [rev-rack] is recognized when a customer sign off on the services that we were contracted to perform and there were some timing issues with that that caused it -- we think that recovers in subsequent quarters.

And I think the side part of your question was whether the VARs will provide, I think that's potentially to come. I think our intention right now, at a level of comfort, I think it's likely for us to do that. Today we started developing our [prof] services just about a year ago and it's doing really well and is helping us win a lot of business. So the go to market group, they'll make the choice whether it makes sense based on the imports of the customer to do that in-house or as time emerges whether we use the VARs to do that. So that's probably part of our toolkit going forward.

I'd like to add a little bit to the last part of what Clyde was saying. Look, the indirect channel is I think [as low as] 25% of our revenues overall. And yes, to Clyde's point, it did not slow down at all, as a matter of fact it very much kept pace with our overall growth so we feel good about that.

As far as prof service is concerned I guess the majority of our wins, including the majority of our enterprise wins, are direct. So we wouldn't necessarily expect to transition that to VARs but as VARs are growing, of course we also expect them to be more and more self-reliant and to handle their part of the equation. But we do see prof services continuing being a line item for us. But relatively minor in comparison to our recurrent revenue business.

Our next question comes from the line of Heather Bellini with Goldman Sachs. Please proceed with your question.

Hi thanks, this is Nicole Hayashi in for Heather. I do have a higher level strategic question, given Twilio's growth and with Vonage having acquired in the space, I would be interested in your view on whether participating in this software category a little further down the stack would make sense strategically for RingCentral.

Yes. No, very good question, Nicole. We are participating. We're just doing it in a little bit different way.

To remind everyone, of the SaaS providers, not [pass], not platform of the service, but software of the service providers in our space, we are the only ones with an open platform with hundreds of developers developing to our open APIs and with dozens of applications already having been developed. And we continue seeing innovative use cases whereby customers will implement custom workflows.

We have one example where a fast food chain customer is using our platform to notify their customers of the status of their takeout orders. And so we are very much in that space.

We don't feel that we necessarily need to compete purely head-to-head and take on their business model of transactional monetization. Again to remind everyone, with the exception of Pro services and a little tiny bit of remnant phone revenue, all of our revenues is recurrent and of new business 75% is now under contract. So we like that position. (Inaudible) here's Twilio's model, but we think it has legs.

Great. Thank you.

Our next question comes from the line of Mike Latimore, Northland Securities, Inc. Please proceed with your question.

Hey guys this is Nick Altman on for Mike. Thank you for taking my questions. And terms of competition, can you guys give us any update on what you are seeing in terms of competition and specifically what you guys are seeing from Skype for Business and the cloud PBX?

Sure. So Skype for Business, let's start with that. So they continue not having a complete cloud solution. They do not really, today, offer anything that could be termed a cloud PBX. Simple case in point, there's not a (inaudible) that is available for Microsoft in the cloud. And that is really what differentiates a very basic cloud PBX at least needs to have that.

So we don't see them directly. If anything, we hear of link on-prem legacy customers being kind of interested in what Microsoft will eventually do in the cloud. But we don't see them today as direct competitors by any stretch.

Having said that and other than (inaudible) that of course there are lots of Microsoft -based businesses out there. We can serve them very well today with our Office 365 and Outlook and Skype for Business integration. Those integrations are valued by customers, they have a following.

These integrations are approved and well-liked by Microsoft. You may remember, we had a joint press release several quarters ago and we're quite happy to be able to complete the Microsoft cloud suite with our RingCentral office software.

Ladies and gentlemen in the interest of time if you can limit yourself to one question. Thank you. Our next question comes from the line of Sterling Auty with JPMorgan. Please proceed with your question.

Hey guys this is Jackson Ader on for Sterling. I will keep it to one. Our question really, has any indirect channel, has there been any kind of shakeup at all in terms of top partners and their contribution?

Sure. Has there any type of shakeup? Well we keep on signing up new partners. As I mentioned, our partners are contributing across board. So there is always movement. There is always movement and we have already indicated that as a class, our VARs are, on a relative basis, outperforming our carriers a little bit. But both are still contributing.

Our next question comes from the line of Barry McCarver from Stephens Inc. Please proceed with your question.

Good afternoon guys, great quarter. I've got a question on M&A. A nice balance of cash on the balance sheet there. Anything you might be looking at?

We look, people give us ideas. There is no shortage of ideas certainly from the south side. But we are focused a lot on organic growth and opportunity is certainly there as we discussed earlier. One M&A we did about a year ago was Glip and it was hugely successful and it's helping us quite a lot fell out our portfolio. So I think it demonstrates we're willing to do it and we will be prudent and disciplined about doing it.

So we don't reject those ideas. We listen to those ideas. But I think we will be opportunistic for the right opportunities, right variations that would help accelerate our growth and our profitability. That's where I think you'll see us doing more.

Our next question comes from the line of Brian Schwartz, Oppenheimer & Co. Please proceed with your question.

One question for Clyde. I don't know if you want to make the comment either qualitatively and quantitatively, but can you talk about the booking mix in the quarter and how much of the percentage of the new business that is coming in is coming from upselling the existing base versus new customer sign-ups? Thanks.

I think in either Vlad's or mine -- we said about 40% of our new bookings come from existing customers, Brian, so we put that specifically out there. So there was a lot of tailwinds from that and you would expect that, right? For several years we have been telling you that we've been going after larger customers. We've also been describing land and expand, so this is the product and the metric of that success.

So it's quite meaningful that we do it and it demonstrates the stickiness of the product where existing customers continue to buy more. And so if you look at our cohort basis you will see that very clearly and [just to tease that] out for you, we will cover more of that at our upcoming analyst day.

Our next question comes from the line of Jonathan Kees, Summit Research Partners. Please proceed with your question.

Great. Congratulations on the quarter and thanks for taking my question. Just real quick, I was curious about the commentary, during your prepared remarks you talked about Google and the partnership there and the potential there and the fact they attended your user conference. It was not until a couple questions ago that there was any discussion of Microsoft. Obviously you're partnered with them in terms of office and you're integrating with them in terms of the Office 365 and Outlook and stuff like that. Do you still see as much potential there is you would with Google and do you see more potential now with Google? Were they even at that user conference a month ago?

Thanks for the congrats. No. Microsoft was not at our user conference, Google was. And to be clear, as far as company to company today, we have I would say a closer relationship with Google directly as opposed to with Microsoft directly. We still support both Google cloud or G Suite customers as well as Microsoft Office 365 customers and we do that via our integration that we just discussed.

As far as potential is concerned, sure. We think there was a lot of potential on both sides. The fact of the matter is, that if you are a business that wants to move its IT to the cloud, which is now almost every business of any size, almost anywhere in the world, then as far as your productivity suite is concerned there are two choices. There is Microsoft and Google.

We are fortunate to have been one of the few chosen partners for Google and specifically in this space, we feel we are getting quite a bit of attention from them. We are hoping that there will be opportunities to work even closer with Microsoft as well.

We have time for one last question. Our last question comes from the line of Will Power with Robert W. Baird. Please proceed with your question.

This is Charlie filling in for Will. I wanted to ask about the competitive landscape in enterprise versus SMB using different competitors in each space and which specifically are you seeing? Thanks.

Yes. So, look, in the enterprise, most of the time we see a legacy providers. We see Cisco and Avaya, and we're replacing tons of both. So there's a lot to love there. It's a very, very large market that's dominated by legacy players whose solutions are no longer meeting the needs of modern businesses.

We see legacy providers all the way down to mid and even sometimes smaller businesses because even if you have a 20 person shop chances are you have a box of some kind, a PBX or smaller PBX or key system, we're replacing those.

But if your question is about other cloud providers, we have the usual suspects of the companies that are publicly held and might be on your radar. We see Vonage in the lower end of the market with smaller businesses. We see 8x8 in the mid market.

Our data suggest that we are winning a meaningful portion of our deals. And very importantly, we are now beginning to see takeaways, I think I mentioned some of them some examples in the prepared remarks, to our customers who have already chosen a cloud provider are now moving -- switching horses and going to RingCentral based on our quality of service, ease of use and just ability to support their needs globally.

I do want to remind everyone, we have been consistently out-investing our direct competition on the product side and the innovation side. And we have been doing that for several years now and these investments are definitely bearing fruit. We expect to be winning more business, of course most of the market is still Greenfield but we feel very, very confident from the competitive perspective.

Look, overall, numbers speak for themselves. You know what our growth has been, is, we are confident and will continue at a very healthy pace. And we are confident that based on the extreme recent growth in our enterprise pipeline that this 5000 user deal we've talked about a bit today, it's not an aberration. There will be more to come and even larger deals than that.

This does conclude the Q&A session. I would like to hand the call back over to management for closing comments.

Thanks, Doug. Thanks all of you for joining the call today and spending time to learn more about RingCentral. We certainly appreciate that and we will see you at the analyst day. Thank you.

Ladies and gentlemen this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time and have a wonderful day.